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Thursday, January 23, 2014

Fed Outlook: Autopilot Until 2015?

As a short update to my Fed outlook piece, it looks like the base case is that the Fed will continue to taper by $10 billion per meeting. Things only get really interesting at the end of this year, as Fed decisions will become meaningful again in early 2015. In the meantime, the main topic of interest seems to be tail risks, in particular, recession risks.

(NOTE: My 2015 Outlook for the Fed is available; updated in November 2014.)

This article by Tim Duy summarises the factors heading into next week's Federal Open Market Committee (FOMC) meeting. Part of his concluding remarks:
Bottom Line:  The US economy is grinding forward.  Policymakers are generally comfortable with the pace of tapering at $10 billion per meeting.  That could be reconsidered if we see sustained weakness in future data, but I don't think that should be the base case.
The main reason I see the FOMC surprising me next week (by not "tapering" by $10 billion a month) is that it wants to inject some uncertainty into the terminal date of Quantitative Easing (QE). My guess is that this is not a priority for them; there is no reason to believe that the bond markets are particularly complacent about Fed policy. Under my base case pace of tapering, QE will be finished by year end. After which point it is possible that the Fed could hikes rates.

The most hawkish scenario for the Fed I see as being plausible is a hike in early 2015. Conversely, a bond bull is happy with a first hike at any point between 2016-2025 (you are being paid to hold bonds versus cash). As such, the battleground is over what happens in early 2015.

Given the time intervals involved, my suggestion is to not worry about the short-term noise. As we have repeatedly discovered over the past four years, the automatic stabilisers have damped out the impact of the squiggles in growth. (For example, did it really matter whether 2012Q3 GDP was above or below expectations?) Instead, spend your time analysing the tail risks, in particular recession risks. Warren Mosler has been giving reasons to expect growth to dip lower (for example, expiring tax breaks), which puts the economy uncomfortably close to recessionary territory. That said, I still think we need something relatively big to push the economy through the effect of the stabilisers. (I obviously do not know what that thing is, or I would be writing about it.) It is only if we make it through the year without a recession that the subject of spare capacity will once more come onto the radar screen.

See Also:

(c) Brian Romanchuk 2014


  1. I don't know about you but I am more then ready for rate hikes. So you think early 2015? I could see that. I would think H2 2014 but would not be surprised if you are right.

  2. I think that 2014 is too early on the grounds that QE will be just wrapped up near year end, under my assumed path of tapering by $10 billion a meeting. At which point, they might as well wait to see how Christmas sales have done.

    We would need some very impressive acceleration in the economy to force a rate hike this year. The expansion is about four years old now; I'm skeptical that the economy will suddenly take off over the next couple of quarters.


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